When most of us hear the term “insider information,” our ears perk up. It’s taboo among personal investors to even mention the phrase at times, but that’s because most of us never seem to get any good insider information. Generally, the people with that kind of knowledge are CEOs like Martha Stewart or high-ranking company officers, and I bet they know how to use it.
If anyone thinks the CEOs or board of directors at Fortune 500 companies aren’t using inside information, you are putting a lot of faith into the top 1% of our society. Regardless of whether you think it’s right or not, I bet it probably happens more often than you might imagine. How many stories have we heard over the past few years of executives taking huge bonuses even though their company was laying off workers or bailed out by taxpayers? These people don’t get to the top by having solid character and strong moral fiber, trust me.
How Do They Get Away With It?
If we assume that insider trading is going on, then how on earth are so many people getting away with it? We rarely hear stories about insider trading anymore and I think the answer is pretty simple. Just think about the millions of trades, if not more, that occur each day. How the hell is someone supposed to pick out an insider trader out of millions of transactions? That responsibility falls squarely on the shoulders of the Securities and Exchange Commission (SEC).
I can’t speak to the efficiency of the SEC but I do know how efficient other government programs are. Been to the DMV lately? If that’s even 1/10th efficient as the SEC then you have your answer. Honestly, I’m surprised anyone’s ever caught since it’s so easy to have someone else make the purchase for you or do small amounts to not get noticed. Obviously if you get greedy and do it with a few million dollars that might raise some red flags.
Just What is Inside Information?
I worked for a Fortune 500 aerospace corporation for four years and our stock price was constantly going up or down based on our earnings reports and whether we were winning new programs or not. I was a lowly engineer but everyone liked to gossip a lot about our end-of-the-year bonus (based on company revenue) and whether we would be winning any new programs or not. Honestly, most of the time the rumors were true. I don’t think this would be considered insider information but I could have definitely made some money off the happenings at my company this way.
Let’s imagine I was in more of a manager role — involved in high-level meetings with VPs and in on the calls with potential customers. Since a lot of employees own company stock what should they do if they find out the company is not going to win that hot new program? They know that once it’s announced the stock price will go down at least a couple percent if not more. I’ve never been faced with this type of situation but I do know for a fact that this is insider information.
I would probably be too scared to do anything in that situation since most people know the penalty for insider trading is jail time. But what if I heard it secondhand from someone who was in the meeting? Even though that is probably still considered insider trading, it’s up to me to believe the source or not. I think most people would be more willing to make a trade based off reliable secondhand information since it doesn’t feel like you’re doing anything wrong.
The Government Uses Fear to Stop Insider Trading
I’ve already mentioned Martha Stewart since she’s clearly one of the biggest examples of insider trading. If you’re not familiar with the case, she was sent to jail for five months for selling $230,000 worth of ImClone stock, a drug company that was about to have their latest drug rejected by the FDA. She was only caught because the executives at ImClone all sold tens of millions of dollars of stock right before the FDA announcement. Even the geniuses at the SEC could connect the dots and figure that one out.
But the reason why I bring this example up is that we all know how severe the penalty is for insider trading because of this case. People break the law every day, whether it’s jaywalking or littering, but we’re scared of insider trading because of stories like this. We know we probably won’t even get a ticket for illegally crossing the street. Stewart ended up doing five months in jail and had she not sold her stock, she would have taken nearly $50,000 in losses. I’m sure she had to pay the money back but would you risk $50,000 for five months in jail? If I was a millionaire like Martha Stewart, I sure as hell wouldn’t but if my 401(k) was at stake, I might have to think twice about it.
Readers, would you invest with firsthand or secondhand inside information? Do you think the SEC would really catch you and prosecute you for insider trading in amounts under $10,000? What about $50,000 or $100,000?
Harry Campbell is a staff writer for the College Investor and runs his own personal finance blog at Your PF Pro where he talks about everything from saving money at Chipotle to asset allocation for retirement. Harry currently resides in San Diego, CA and also works full time as an aerospace engineer and part time as a club volleyball coach.